Why Hawtrey and Cassel Trump Friedman and Schwartz

This year is almost two-thirds over, and I still have yet to start writing about one of the two great anniversaries monetary economists are (or should be) celebrating this year. The one that they are already celebrating is the fiftieth anniversary of the publication of The Monetary History of the United States 1867-1960 by Milton Friedman and Anna Schwartz; the one that they should also be celebrating is the 100th anniversary of Good and Bad Trade by Ralph Hawtrey. I am supposed to present a paper to mark the latter anniversary at the Southern Economic Association meetings in November, and I really have to start working on that paper, which I am planning to do by writing a series of posts about the book over the next several weeks.

Good and Bad Trade was Hawtrey’s first publication about economics. He was 34 years old, and had already been working at the Treasury for nearly a decade. Though a Cambridge graduate (in mathematics), Hawtrey was an autodidact in economics, so it is really a mistake to view him as a Cambridge economist. In Good and Bad Trade, he developed a credit theory of money (money as a standard of value in terms of which to discharge debts) in the course of presenting his purely monetary theory of the business cycle, one of the first and most original instances of such a theory. The originality lay in his description of the transmission mechanism by which money — actually the interest rate at which money is lent by banks — influences economic activity, through the planned accumulation or reduction of inventory holdings by traders and middlemen in response to changes in the interest rate at which they can borrow funds. Accumulation of inventories leads to cumulative increases of output and income; reductions in inventories lead to cumulative decreases in output and income. The business cycle (under a gold standard) therefore was driven by changes in bank lending rates in response to changes in lending rate of the central bank. That rate, or Bank Rate, as Hawtrey called it, was governed by the demand of the central bank for gold reserves. A desire to increase gold reserves would call for an increase in Bank Rate, and a willingness to reduce reserves would lead to a reduction in Bank Rate. The basic model presented in Good and Bad Trade was, with minor adjustments and refinements, pretty much the same model that Hawtrey used for the next 60 years, 1971 being the year of his final publication.

But in juxtaposing Hawtrey with Friedman and Schwartz, I really don’t mean to highlight Hawtrey’s theory of the business cycle, important though it may be in its own right, but his explanation of the Great Depression. And the important thing to remember about Hawtrey’s explanation for the Great Depression (the same explanation provided at about the same time by Gustav Cassel who deserves equal credit for diagnosing and explaining the problem both prospectively and retrospectively as explained in my paper with Ron Batchelder and by Doug Irwin in this paper) is that he did not regard the Great Depression as a business-cycle episode, i.e., a recurring phenomenon of economic life under a functioning gold standard with a central bank trying to manage its holdings of gold reserves through manipulation of Bank Rate. The typical business-cycle downturn described by Hawtrey was caused by a central bank responding to a drain on its gold reserves (usually because expanding output and income increased the internal monetary demand for gold to be used as hand-to-hand currency) by raising Bank Rate. What happened in the Great Depression was not a typical business-cycle downturn; it was characteristic of a systemic breakdown in the gold standard. In his 1919 article on the gold standard, Hawtrey described the danger facing the world as it faced the task of reconstructing the international gold standard that had been effectively destroyed by World War I.

We have already observed that the displacement of vast quantities of gold from circulation in Europe has greatly depressed the world value of gold in relation to commodities. Suppose that in a few years’ time the gold standard is restored to practically universal use. If the former currency systems are revived, and with them the old demands for gold, both for circulation in coin and for reserves against note issues, the value of gold in terms of commodities will go up. In proportion as it goes up, the difficulty of regaining or maintaining the gold standard will be accentuated. In other words, if the countries which are striving to recover the gold standard compete with one another for the existing supply of gold, they will drive up the world value of gold, and will find themselves burdened with a much more severe task of deflation than they ever anticipated.

And at the present time the situation is complicated by the portentous burden of the national debts. Except for America and this country, none of the principal participants in the war can see clearly the way to solvency. Even we, with taxation at war level, can only just make ends meet. France, Italy, Germany and Belgium have hardly made a beginning with the solution of their financial problems. The higher the value of the monetary unit in which one of these vast debts is calculated, the greater will be the burden on the taxpayers responsible for it. The effect of inflation in swelling the nominal national income is clearly demonstrated by the British income-tax returns, and by the well-sustained consumption of dutiable commodities notwithstanding enormous increases in the rates of duty. Deflation decreases the money yield of the revenue, while leaving the money burden of the debt undiminished. Deflation also, it is true, diminishes the ex-penses of Government, and when the debt charges are small in proportion to the rest, it does not greatly increase the national burdens. But now that the debt charge itself is our main pre-occupation, we may find the continuance of some degree of inflation a necessary condition of solvency.

So 10 years before the downward spiral into the Great Depression began, Hawtrey (and Cassel) had already identified the nature and cause of the monetary dysfunction associated with a mishandled restoration of the international gold standard which led to the disaster. Nevertheless, in their account of the Great Depression, Friedman and Schwartz paid almost no attention to the perverse dynamics associated with the restoration of the gold standard, completely overlooking the role of the insane Bank of France, while denying that the Great Depression was caused by factors outside the US on the grounds that, in the 1929 and 1930, the US was accumulating gold.

We saw in Chapter 5 that there is good reason to regard the 1920-21 contraction as having been initiated primarily in the United States. The initial step – the sharp rise in discount rates in January 1920 – was indeed a consequence of the prior gold outflow, but that in turn reflected the United States inflation in 1919. The rise in discount rates produced a reversal of the gold movements in May. The second step – the rise in discount rates in June 1920 go the highest level in history – before or since [written in 1963] – was a deliberate act of policy involving a reaction stronger than was needed, since a gold inflow had already begun. It was succeeded by a heavy gold inflow, proof positive that the other countries were being forced to adapt to United States action in order to check their loss of gold, rather than the reverse.

The situation in 1929 was not dissimilar. Again, the initial climactic event – the stock market crash – occurred in the United States. The series of developments which started the stock of money on its accelerated downward course in late 1930 was again predominantly domestic in origin. It would be difficult indeed to attribute the sequence of bank failures to any major current influence from abroad. And again, the clinching evidence that the Unites States was in the van of the movement and not a follower is the flow of gold. If declines elsewhere were being transmitted to the United States, the transmission mechanism would be a balance of payments deficit in the United States as a result of a decline in prices and incomes elsewhere relative to prices and incomes in the United States. That decline would lead to a gold outflow from the United States which, in turn, would tend – if the United States followed gold-standard rules – to lower the stock of money and thereby income and prices in the United States. However, the U.S. gold stock rose during the first two years of the contraction and did not decline, demonstrating as in 1920 that other countries were being forced adapt to our monetary policies rather than the reverse. (p. 360)

Amazingly, Friedman and Schwartz made no mention of the accumulation of gold by the insane Bank of France, which accumulated almost twice as much gold in 1929 and 1930 as did the US. In December 1930, the total monetary gold reserves held by central banks and treasuries had increased to $10.94 billion from $10.06 billion in December 1928 (a net increase of $.88 billion), France’s gold holdings increased by $.85 billion while the holdings of the US increased by $.48 billion, Friedman and Schwartz acknowledge that the increase in the Fed’s discount rate to 6.5% in early 1929 may have played a role in triggering the downturn, but, lacking an international perspective on the deflationary implications of a rapidly tightening international gold market, they treated the increase as a minor misstep, leaving the impression that the downturn was largely unrelated to Fed policy decisions, let alone those of the IBOF. Friedman and Schwartz mention the Bank of France only once in the entire Monetary History. When discussing the possibility that France in 1931 would withdraw funds invested in the US money market, they write: “France was strongly committed to staying on gold, and the French financial community, the Bank of France included, expressed the greatest concern about the United States’ ability and intention to stay on the gold standard.” (p. 397)

So the critical point in Friedman’s narrative of the Great Depression turns out to be the Fed’s decision to allow the Bank of United States to fail in December 1930, more than a year after the stock-market crash, almost a year-and-a-half after the beginning of the downturn in the summer of 1929, almost two years after the Fed raised its discount rate to 6.5%, and over two years after the Bank of France began its insane policy of demanding redemption in gold of much of its sizeable holdings of foreign exchange. Why was a single bank failure so important? Because, for Friedman, it was all about the quantity of money. As a result Friedman and Schwartz minimize the severity of the early stages of the Depression, inasmuch as the quantity of money did not begin dropping significantly until 1931. It is because the quantity of money did not drop in 1928-29, and fell only slightly in 1930 that Friedman and Schwartz did not attribute the 1929 downturn to strictly monetary causes, but rather to “normal” cyclical factors (whatever those might be), perhaps somewhat exacerbated by an ill-timed increase in the Fed discount rate in early 1929. Let’s come back once again to the debate about monetary theory between Friedman and Fischer Black, which I have mentioned in previous posts, after Black arrived at Chicago in 1971.

“But, Fischer, there is a ton of evidence that money causes prices!” Friedman would insist. “Name one piece,” Fischer would respond. The fact that the measured money supply moves in tandem with nominal income and the price level could mean that an increase in money causes prices to rise, as Friedman insisted, but it could also mean that an increase in prices causes the quantity of money to rise, as Fischer thought more reasonable. Empirical evidence could not decide the case. (Mehrling, Fischer Black and the Revolutionary Idea of Finance, p. 160)

So Black obviously understood the possibility that, at least under some conditions, it was possible for prices to change exogenously and for the quantity of money to adjust endogenously to the exogenous change in prices. But Friedman was so ideologically committed to the quantity-theoretic direction of causality from the quantity of money to prices that he would not even consider an alternative, and more plausible, assumption about the direction of causality when the value of money is determined by convertibility into a constant amount of gold.

This obliviousness to the possibility that prices, under convertibility, could change independently of the quantity of money is probably the reason that Friedman and Schwartz also completely overlooked the short, but sweet, recovery of 1933 following FDR’s suspension of the gold standard in March 1933, when, over the next four months, the dollar depreciated by about 20% in terms of gold, and the producer price index rose by almost 15% as industrial production rose by 70% and stock prices doubled, before the recovery was aborted by the enactment of the NIRA, imposing, among other absurdities, a 20% increase in nominal wages. All of this was understood and explained by Hawtrey in his voluminous writings on the Great Depression, but went unmentioned in the Monetary History.

Not only did Friedman get both the theory and the history wrong, he made a bad move from his own ideological perspective, inasmuch as, according to his own narrative, the Great Depression was not triggered by a monetary disturbance; it was just that bad monetary-policy decisions exacerbated a serious, but not unusual, business-cycle downturn that had already started largely on its own. According to the Hawtrey-Cassel explanation, the source of the crisis was a deflation caused by the joint decisions of the various central banks — most importantly the Federal Reserve and the insane Bank of France — that were managing the restoration of the gold standard after World War I. The instability of the private sector played no part in this explanation. This is not to say that stability of the private sector is entailed by the Hawtrey-Cassel explanation, just that the explanation accounts for both the downturn and the subsequent prolonged deflation and high unemployment, with no need for an assumption, one way or the other, about the stability of the private sector.

Of course, whether the private sector is stable is itself a question too complicated to be answered with a simple yes or no. It is one thing for a car to be stable if it is being steered on a paved highway; it is quite another for the car to be stable if driven into a ditch.

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36 Responses to “Why Hawtrey and Cassel Trump Friedman and Schwartz”

“Of course, whether the private sector is stable is itself a question too complicated to be answered with a simple yes or no. It is one thing for a car to be stable if it is being steered on a paved highway; it is quite another for the car to be stable if driven into a ditch.”

“Friedman was so ideologically committed to the quantity-theoretic direction of causality from the quantity of money to prices”

This is a crucial point, but you are also missing Hawtrey’s fundamentally different view to Friedman’s about what was happening to the US economy during the 1920’s. According to Friedman and Schwarz the US economy was operating at equilibrium because of stable money supply and stable prices. (Exactly the same argument used by the neo-classical synthesis to justify the Great Moderation). Hawtrey in the Art of Central Banking highlighted that the US was in fact going through a cumulative (Wicksellian) credit process, whereby the natural rate of interest rose each each year from 1924-29 whilst the money rate of interest fell.

Very good article, David. And convincing a lot. I never understood the position of Friedman that 1929’s was normal recession, not originated but agravated By the posterior mistakes of the FED.
You are right in saying that:
“Not only did Friedman get both the theory and the history wrong, he made a bad move from his own ideological perspective, inasmuch as, according to his own narrative, the Great Depression was not triggered by a monetary disturbance…”
In any case, with your (or Hawtrey’s) narrative, the facts are much better explained.

1. It required that all gold and gold certificates held by the Federal Reserve be surrendered and vested in the sole title of the United States Department of the Treasury

2. The Gold Reserve Act outlawed most private possession of gold, forcing individuals to sell it to the Treasury, after which it was stored in United States Bullion Depository at Fort Knox and other locations.

3. The act also changed the nominal price of gold from $20.67 per troy ounce to $35.

“Executive Order 6102 required all persons to deliver on or before May 1, 1933, all but a small amount of gold coin, gold bullion, and gold certificates owned by them to the Federal Reserve, in exchange for $20.67…”

I just don’t see a causal link between the recovery of 1933 and Executive Order 6102.

Matt, Actually, the metaphor isn’t mine. Perhaps I should have credited it to someone. I found it in a paper by David Laidler, but I’m not sure if it’s his or someone else’s.

Marcus, Thanks. There really are very few economists other than specialists in the history of economics who have any knowledge about Hawtrey and his work. I am not sure, but I think that Cassel might be marginally better known.

Blue Aurora, I hope not to keep you waiting too long for some posts about Good and Bad Trade.

Tom, I am not aware that that is what Hawtrey said about the US economy. Do you have a page reference for me?

Don, Thanks.

Luis, Thanks. Yes both Keynes and Hawtrey were worried about the restoration of the gold standard. Keynes opposed going back on gold; Hawtrey favored doing so. Hawtrey thought that the gold standard could be made to work if the central banks cooperated and followed sane policies. He was right, but he was too optimistic in estimating the chances of success.

Frank, The devaluation of the dollar against gold is clearly evident in the depreciation of the dollar against the French franc which was convertible into gold until about 1935 or 1936. The dollar depreciated against the franc by over 20% from April to July of 1933.

“Roosevelt’s most dramatic use of the Thomas amendment came on January 31, 1934, when he decreased the gold content of the dollar to 40.94 percent.”

I think we can agree that meaningful action by President Roosevelt and Congress did not happen until 1934 – Thomas Amendment power exercised by Roosevelt and Gold Reserve Act enacted by Congress. And so to say that the “short, but sweet recovery of 1933” was a direct result of actions taken by Roosevelt in early 1933 is misleading.

Would someone please explain what has all this got to do with ‘the price of tea in China’ ( both metaphorical, and literal, meaning)?

When one is in total control of the three forms of money supply – fiat, gold, and digital, plus all the money lending institutions – IMF, World Bank, IBRD, World Bank, et al; add to this the International Banking fraternity; and let us not forget, the independent of Government – Federal Reserve – ‘walking on economic water’, turning water into wine, and feeding the multitudes with enough loaves, and fishes, to keep them from taking up arms against the slings and arrows aimed at them, is child’s play.

And all that is a mere small percentage of the power behind the throne of international, economic, administration.

In the digital, and virtual, age, nothing has to really exist. In fact, I doubt if there is sufficient paper to produce all the notes that would be required if the sums of money discussed today by TV ‘economists’ were rolled off the presses. And, in spite of what is uttered by any Fed chairman, there will be no end in site for quite a long time.

When Adam Smith sat down to write his ‘Wealth of Nations’ the known population of the entire world was hardly that of today’s China.

In the mid nineteenth century, the man who would have been referred to by today’s media indoctrination as ‘the most powerful man in the world’ because he sat atop the world’s largest geographic, and economic empire – Benjamin Disraeli wrote – ‘This world is governed by personages, unimagined by those not behind the scenes’. (Coningsby)

He did not write – this England, this Britain, this Empire, he wrote ‘THIS WORLD!.

That one sentence, by a most erudite ‘personage’ of his time, in a position of immense influence, and power, should be sufficient to inform any ‘economist’ worth his salt that ‘all is not what it seems’.

While there is some use for ‘theories’, especially good ones, their usefulness should be confined to tell us, when they are breached, to ask ourselves ‘why’. Let us not assume that because it defies our understanding, it is an administrative failing of economic naivety. It is more likely due to our lack of ‘imagination’ that permits one to see, and observe, ‘behind the scenes.’

To solve crimes – even economic ones, one starts with motivation, and motivation starts with – who benefits the most.

“I am enough of the artist to draw freely upon my imagination. Imagination is more important than knowledge. Knowledge is limited. Imagination encircles the world.” (A. Einstein)

Frank, Traders can anticipate all they want to, but as long as the US remained on the gold standard, the spot dollar price of gold and the spot dollar/franc exchange rate would not budge. The 20% depreciation in the dollar/franc exchange rate is undeniable proof that the US was no longer on the gold standard, and it was no longer on the gold standard because FDR took us off. Whether he had the legal authority to do so or not is irrelevant.

Ray, Very interesting, indeed, but I am sorry to have to admit that I don’t understand a word of it.

“Frank, Traders can anticipate all they want to, but as long as the US remained on the gold standard, the spot dollar price of gold and the spot dollar/franc exchange rate would not budge.”

Maybe you and I have different views on what the gold standard actually was. The gold standard that I had in mind was that the central bank of such and such country was an unlimited buyer for gold at a fixed exchange rate. A central bank cannot operate a fractional lending system and simultaneously be an unlimited seller for gold at the same fixed exchange rate. There are always more bank notes floating around then there is gold available for redemption.

If you insist that a gold standard must include the banking system being able to meet all redemption demands (100% gold reserve system) then the proper date for the end of the gold standard would be 1913 – First federal reserve act establishing federal reserve notes as legal tender alongside U. S. government issued greenbacks.

Changes in reserve requirements between two countries that have fractional reserve banking systems will affect the relative value of those currencies (Franc versus Dollar in this instance), even while a gold standard is maintained by both countries.

“The 20% depreciation in the dollar/franc exchange rate is undeniable proof that the US was no longer on the gold standard…”

All that the 20% depreciation in the dollar/franc exchange rate tells you is that there was a higher demand for francs relative to the supply of francs than there was demand for dollars relative to the supply of dollars.

Frank, As long as “the central bank of such and such a country was an unlimited buyer for gold at a fixed exchange rate,” the observed exchange rate would not deviate from the fixed exchange rate. So under your own definition, the US was not on the gold standard once its exchange rate against the franc depreciated from the rate dictated by the official gold parity. The reason of course is that FDR stopped gold from being exchanged for dollars. The US could have maintained a fixed exchange rate against the franc even without selling gold, but instead allowed the dollar to depreciate in the FX markets.No central bank ever held enough gold in reserve to redeem all its outstanding liabilities, just as no US commercial bank ever held enough gold or dollars to redeem all of its banknotes or deposits for gold or US currency. But under a gold standard, the dollar exchanged at par with gold, just as bank deposits exchange at par with US currency. Reserve requirements are irrelevant to whether a bank’s liabilities exchange at par with the outside asset into which it promises to convert its liabilities.

You said:

“If you insist that a gold standard must include the banking system being able to meet all redemption demands (100% gold reserve system) then the proper date for the end of the gold standard would be 1913 – First federal reserve act establishing federal reserve notes as legal tender alongside U. S. government issued greenbacks.”

I don’t know why you would attribute such a misguided idea to me. I reject it completely. A gold standard could operate perfectly well with zero gold reserves.

You said:

“Changes in reserve requirements between two countries that have fractional reserve banking systems will affect the relative value of those currencies (Franc versus Dollar in this instance), even while a gold standard is maintained by both countries.”

The relative value of two currencies on the gold standard is determined entirely by the ratio of the countries’ conversion rates. Reserve requirements have no effect on the relative value of the two currencies, but would affect the absolute value of gold. The higher the reserve requirement the higher the value of gold, but the value of gold is equal in both countries. Gold is a tradable commodity and arbitrage ensures that its value is the same in all locations where it can be bought and sold freely.

“The reason of course is that FDR stopped gold from being exchanged for dollars.”

No he didn’t. Executive order 6102 (authorized by Roosevelt) required all citizens to exchange most of their gold holding for dollars. Precisely twenty dollars and sixty seven cents per troy ounce of gold.

How does a central bank or government peg their currency to a fixed amount of gold with no reserves to sell and while not building up a supply of reserves?

“The relative value of two currencies on the gold standard is determined entirely by the ratio of the countries’ conversion rates.”

Wrong. Just bloody wrong. Because the entire stock of currency outstanding is not convertible to gold (fractional reserve banking), the relative value of two currencies is a function of both the rate of exchange AND the amount that can be exchanged (reserve ratio).

Picture one country (France) backing all of their currency with gold at a fixed exchange rate. Picture another country (U. S.) doing the same. Now picture the U. S. changing from a 100% backing to a 1% backing at the same exchange rate and increasing the amount of currency in circulation to reflect the new reserve ratio.

Meaning amount of Francs in circulation is unchanged, amount of Dollars increases 100 fold. This will have no effect on the exchange rate between Dollars and Francs?

“…..Ray, Very interesting, indeed, but I am sorry to have to admit that I don’t understand a word of it….”

Something along those lines was not unexpected when I opened my comment with, what I assumed would be taken as, a rhetorical question.

Your response echoed the words of Thomas Gray – …”.where ignorance is bliss, ’tis folly to be wise..” This is a phrase of wisdom, I guess, one must embed in the mind, when one chooses to sell one’s soul to the US government (gleaned from your profile).

However, your response questions my intelligence, and does nothing to enhance your own. ‘..to not understand a word of it?’ Not ‘a word- really? Is this not a little over the top of exaggeration to explain an inability to admit to accepting its sound, and supported, where required, reasoning?

To further analyse your comment – ‘ I find it very interesting, but……’

A man of science, I have always believed, when confronted by ‘something VERY INTERESTING, but defying his current understanding, was the spark that ignited the enlightenment from which he was later able to illuminate the lives of mankind ( should I also include ‘woman kind’?)

David, you are failing to observe, like so many of academia’s ( been there, worn the sweater) old breed, that, today, there is a sweet breath of fresh air sweeping our world that is blowing away old dogmas, and the conditioning forces designed to put them there, and waste our time debating them and grace them with false relevance, in a world that daily provides the evidence they have none.

Domestic gold suspension officially began in March 1933. When banks were reopened on March 10 after the bank holiday, they were forbidden from redeeming notes/deposits in gold (including the Reserve banks). At the same time, FDR made the foreign movement of gold illegal without an export license. The decision to force citizens to render their gold up to the Fed was announced on April 11, but people did not yet expect the official gold price to be changed, so equity markets and exchange markets were still quiet. On April 18 FDR ceased granting export licenses. Only then did the gold price finally start to rise (along with equities, forex, and commodities). Both the inconvertibility of dollars domestically and the banning of foreign exports meant that the US was now completely off the gold standard. From then until mid July, the Dow experienced one of its most terrific rises in history, almost doubling. I have data on the yen/$ exchange rate which shows the yen rising by 21% over that time period. And David points out the same happened with the franc.

The 1934 Act was just a formality. Everything was already complete by late 1933.

Frank, When I said that FDR stopped gold from being exchanged for dollars, I meant that he stopped the Fed and the Treasury from giving bearers of dollars gold in exchange for their dollars. When he nationalized the domestic supply of gold, he paid dollars for the gold taken at the official rate rather than simply expropriate it without compensation.

You asked:

“How does a central bank or government peg their currency to a fixed amount of gold with no reserves to sell and while not building up a supply of reserves?”

Simply by selling other assets as needed to conduct transactions in the gold market, in which case, gold reserves are not literally zero, but are almost zero except during the interval between purchases and sales of gold as required to maintain the peg. Fischer Black has a paper on this by the way, in one of his collections of essays. Alternatively, the central bank could peg the exchange rate between its currency to another currency, e.g., the French franc, that is convertible into gold.

You wrote:

“Because the entire stock of currency outstanding is not convertible to gold (fractional reserve banking), the relative value of two currencies is a function of both the rate of exchange AND the amount that can be exchanged (reserve ratio).

“Picture one country (France) backing all of their currency with gold at a fixed exchange rate. Picture another country (U. S.) doing the same. Now picture the U. S. changing from a 100% backing to a 1% backing at the same exchange rate and increasing the amount of currency in circulation to reflect the new reserve ratio.

“Meaning amount of Francs in circulation is unchanged, amount of Dollars increases 100 fold. This will have no effect on the exchange rate between Dollars and Francs?”

Your mistake is to assume that changing the required gold reserve ratio for a currency on the gold standard changes the amount of the currency outstanding. It does no such thing, it simply changes the amount of gold that must be held by the central bank for any given amount of currency that the public chooses to hold. The public is not required to hold more of a convertible currency than they want to. If the government issues more currency, they can simply take it back to the government and exchange it for gold.

Ray, I am not questioning your intelligence, which is obviously considerable; I am just remarking, in haste, that I am unable to follow your argument, and given my other interests, obligations, resources, and constraints, I am not really up to making the intellectual investment in trying to figure out what you are trying to say. If that seems rude, or intellectually closed-minded, to you, I apologize, but there is really nothing in what you are saying that I can latch on to. Undoubtedly my fault, but I can assure you that I am already only too conscious of my considerable shortcomings.

I can however engage with you on whether the value of gold is equalized by arbitrage in all locations where it can be bought and sold. Having reconsidered that assertion, I find that the only change that I would make in that statement is add the qualifier “net of transportation costs.”

JP, Thanks for filling in those historical details. I am so out of it these days, I am only dimly aware of what’s going on. Can you point me to the relevant posts?

Steve Randy Waldman has faithfully put up links to the posts that kick-started the debate (see top) as well as follow ups (see bottom). In brief, the question is: are banks mere financial intermediaries, or do they occupy and unique and special place in the economy? Since the debate has revolved around Tobin 1963, and that’s one of your favorite papers, I figured you might be interested in commenting.

“Frank, When I said that FDR stopped gold from being exchanged for dollars, I meant that he stopped the Fed and the Treasury from giving bearers of dollars gold in exchange for their dollars.”

Okay. FDR suspended convertibility of dollars to gold by private citizens. The central bank was still allowed to buy gold from private citizens at a fixed exchange rate. Gold peg still in effect, bi-directional convertibility has been outlawed.

“Your mistake is to assume that changing the required gold reserve ratio for a currency on the gold standard changes the amount of the currency outstanding. It does no such thing, it simply changes the amount of gold that must be held by the central bank for any given amount of currency that the public chooses to hold.”

I am not assuming that the gold reserve ratio changes the amount of currency outstanding. I am assuming that the demand for currency by the public is infinite (more money at fixed prices = Yee Haw, I am rich!!).

The reserve ratio limits the amount of currency that the public can be physically permitted to hold.

Suppose the demand for francs by French people is infinite (more money = good🙂. The U. S. people feel the same way – infinite demand for dollars. If the French reserve ratio is 100% and the U. S. reserve ratio is 1%, more demands for dollars will get filled than demands for francs – there will be a shortage of francs relative to dollars. Hence the relative values of the two currencies will adjust based on the reserve ratios of the two countries – even if both countries are operating with a gold peg.

“…. but the value of gold is equal in both countries. Gold is a tradable commodity and arbitrage ensures that its value is the same in all locations where it can be bought and sold freely….”

I thought you would clear up what point you were making here.

But you responded:-

“..I can however engage with you on whether the value of gold is equalized by arbitrage in all locations where it can be bought and sold. Having reconsidered that assertion, I find that the only change that I would make in that statement is add the qualifier “net of transportation costs.”..

First we have the term ‘value of gold’. Do you mean by ‘value’ – price of?

Price and value are not interchangeable in argument, unless it is pre-understood.

Second ‘in all locations’ , I am taking to mean ‘between all locations’. The difference being that gold ‘in’ (as within) nation ‘A’ on a macro scale would rarely, if ever, raise the spectre of arbitrage, but between nation A and nation B it could arise, and often does.

However, the meaning of arbitrage is centred on there being a difference in ‘price/value,, and as gold is ‘macro’ traded in US dollars, for arbitrage to take place there must be a difference in the dollar value (price) between the locations. This can be quite considerable though only small in percentage terms, due to the total amount involved in macro trade.

The ‘arbitrageur’ pockets the difference (removes from the economic table).

So, I ask again what point is being made. What is meant by your assertion that arbitrage ensures its value is the same in all locations. I ask because it is possible I have misunderstood your point.

JP, Thanks, I will have a look, but I can’t promise that I will be able to offer any comments.

Frank, If the gold peg was still in effect, it was not a operational. The nominal price of gold and the dollar/sterling exchange rate were still officially maintained during World War I, but no one thinks that the gold standard was operating in any meaningful sense after hostilities started in 1914.

If you are assuming that there is an infinite demand for convertible dollars, then of course the amount of convertible dollars outstanding will increase. But in fact, the amount of convertible dollars would not increase, because the demand for convertible dollars is not infinite. An infinite demand for convertible dollars would mean that people wanted to hold an infinite amount of convertible dollars. No one, including you, wants to hold an infinite amount of convertible dollars. If you had an infinite amount of convertible dollars, you would start spending them on goodies or start buying other assets with them. The amount of convertible dollars outstanding would then start declining as excess dollars would be brought back to the Fed or the Treasury in exchange for gold.

Tom, My quick perusal of the pages from The Art of Central Banking that you referred to, especially section VIII (and section IX which is not in the section you identify) does not at all confirm that Hawtrey thought that there had been a Wicksellian cumulative credit process. He believes that there was a supply-side expansion, but he believes that from 1925 to 1927, after Great Britain went back on the gold standard, Fed policy was too restrictive causing a mini-recession.

Ray, I am using value and price as synonyms, as is customary in most modern writings on economics. My assertion about the value of gold being equalized in all locations in which gold can be freely bought and sold came in the context of a discussion of the gold standard in which the nominal price of gold in terms of a currency is fixed by the monetary authority which promises to buy or sell gold in unlimited quantities at the official price. Under those circumstances the nominal price of gold cannot vary, so arbitrage operates on all tradable commodities. If wheat is more expensive in terms of gold in Paris than in London, then arbitraguers will buy gold in London and sell it in Paris until the price is equalized in both locations. Same holds for all other commodities, so the value of gold in London must equal the value of gold in Paris.

David, I understood full well the context to which your assertion related, but, unlike yourself, I do not profess ignorance of understanding – only a possible misunderstanding of meaning, and/or implication – as in the point being made.

If as you say the word ‘value’ would be understood in ‘modern economics’ to be synonymous with price, that would figure as the word ‘value’ absorbs the vagueness of the ‘worth’ of a good when related to any stated price. And Academia’s economics is based on vagueness, that is why it works so inefficiently, except for those who use its doctrines for ulterior motives, that is perhaps outside of its use in household economics.

Money developed from the need to have a store of value that would hold over the time anticipated when a trader required a good needed for survival, or comfort. This replaced the restrictions imposed by barter.

‘that would hold’ is a key factor. Gold, eventually, was the ‘store of value’ that ticked all the boxes.

I know this is all elementary stuff, but I am keeping it simple to get to my point.

As we know, this gets blown away when over time the first ‘derivatives’ arrive in the form of fiat currency (un-backed except by faith).

However this ‘faith’ holds only among the highly conditioned dumb masses. It is not so among those ‘elite’ who understand the difference between value and price. To them, only gold represented the definitive store of value, and all macro ‘accounting’ is conducted on those terms.

The crunch eventually came in the very early 1970’s, though the problems had been brewing for some time. The Arab Oil Cartel, OPEC started to raise its prices to offset the growing manipulation of the US dollar – the major international currency.

The West was sent reeling by high oil prices causing massive inflation.

A key spokesman (broker) for the Elite Financiers, Kissinger arranged a deal with the Saudis. Simply – they would trade only in US dollars. However, what is rarely, if ever, mentioned by Washington (are you with me David, I feel you cringe) is that the Saudi’s who also understand the difference between price and value, insisted that the trading would be done more on the barter principle – oil for gold, NOT dollars. In other words, they did not trust the dollar as representing VALUE. (as in store of).

It worked this way: Irrespective of the price quoted in dollars for oil, those dollars could be used to convert to gold at a ratio of around 15.5 barrels of crude for 1. ounce of gold.

Obviously, some leeway was permitted for variance to cope with changing economic conditions, just so long as the average, within a reasonable time period, reverted back to the maintain the mean.

This halted the need for OPEC to raise its prices, and some economic stability returned (for the time being). And after all, the Arabs did not want to destroy the west – their bread and butter ( and immense riches for some) source.

As with all things in a life synonymous with change (the key word in Obama’s run for office) – change brought new challenges.

As it is a never ending story, I won’t go on, except to say that a ‘new kid on the block’ has been steadily acquiring the power to challenge the status quo – the hegemony (hegemoney?) of the United States.

It was smart enough to store both dollars, and gold (now the world’s largest producer). This ensures whichever is manipulated, it has the counter play – at least so far. It was the only way it could be done, as China had seen how this manipulation had worked against everyone else to bring them to heel.

OK David, as you mentioned in your closing post on the previous blog topic, and I followed with the request (so far unanswered) would you please let me have your link to where you explained YOUR reasoning why the gold/oil ratio has no significance?

You see, to me, it is one of a number of indications that show we never left a gold standard – in ‘real’ (as in meaningful) terms.

I know some of you here, and I am referring to the ones who post, though I am certain the ones who do not are by far the greater number, are too long in the tooth, plus heavy conditioning, to see outside the box which imprisons their minds.

Therefore, it is to the latter I extend these words of wisdom in the hope that they may one day breathe new life into economics that may help to expunge, as quixotic or non relative, so many quotes of famed personages, past and present, that disparage, and not without just cause, their chosen profession.

I quote the following as one of the many that supports my point, it is lower on cynical humour than most, and focuses on a strong area of failing:,

“….I have arrived at the conviction that the neglect by economists to discuss seriously what is really the crucial problem of our time is due to a certain timidity about soiling their hands by going from purely scientific questions into value questions……”
(Friedrich August von Hayek)

It is hoped, that, armed with a more collective view that embraces an understanding of the difference between Academia’s theory, and Life’s reality as practised, they will be able to bring some ‘sense and sensibility’ (thank you Jane) to the epicentre from where international economics, and its accompanying malpractices, is administered.

“…” It is change, continuing change, inevitable change, that is the dominant factor in society today. No sensible decision can be made any longer without taking into account not only the world as it is, but the world as it will be.”
(Isaac Asimov)

Thank you to those who have endured, as yet in silence and with patience, my many, oft, perhaps, too long, and over the head, posts. To those who dismissed them as irrelevant, or off beat, no hard feelings. To a contrarian thinker, it is par for the course.

Do you not feel that what is the more important upon which to focus,, assuming what you quote is correct, is ‘WHY’ something is done. A cause comes before an effect, the cause, therefore, is responsible for the effect.

In human nature events, as opposed to those occasioned by nature, the cause always has a reason, however valid, and only when we seek to understand the reasoning can we effect a ‘cure’ where one is needed.

Are there not always two sides in these matters – those who act, and those acted upon? Therefore there are two views to be considered, and so should we really assume, so readily, as so many economist appear to do, that the reason (motive) is logically intended to conform to academia’s economic theories, merely because they are all qualified economists and should know better.

In other words, is not the fact that they do not more important to send ‘alarm bells’ ringing, and to seek more qualified answers. What may seem naivety, or incompetence, to one side, may, possibly, be just the opposite to the other. Having said that, I am not inferring that the motive, if all facts were known, and understood, need be malicious and have purely self serving interests, only that taken out of context to the over all economic planned design, and certainly in the near term, they may appear so.

Tom, I am sorry, but I cannot find such a quotation in my copy of The Art of Central Banking.

Here are some quotations that I found:

“A vital condition of this prosperity had been the monetary stability of the period 1922-28, and Governor Benjamin Strong of the New York Federal Reserve Bank, to whom more than to any one the policy of monetary stability had been due, died in the autumn of 1928.” (p. 64)

“In the two years, 1925-27, the expansion of business in the United States was to some extent checked. The commodity price level fell by 10 per cent. Industrial production did not appreciably increase, though the high level reached in 1925 was maintained in 1926 and 1927. The set-back hardly amounted to a depression such as existed for a short time in 1924. Nevertheless the tendency was sufficiently adverse to justify further measures of credit relaxation.” (p. 68)

“But that does not mean that the Federal Reserve Banks caused the speculation by an artificial interference with the course of economic events. On the contrary, it means that by just such an artificial interference they could have prevented it. For the prosperity which attracted speculators was the result of unimpeded economic activity, and credit restriction would have interfered with it by curtailing demand, reducing profits below normal and damping down activity.” (p. 69)

And that’s why it is a very bad idea to quote from notes. It wasn’t on my page 68 either…

On p.41-42 he describes a classic cumulative Wicksellian process whereby profits swell as do asset prices along with inflation due to excessive credit relaxation. The 1920’s period, according to Hawtrey, was different because of the lack of inflation.

However, he does cite credit relaxation by the Federal Reserve driven by a falling discount rate from 1924 through to 1928 and open market purchases in 1927 (p.68). And on p.46-50 he eloquently describes the record profits of the period.

You are right that because of the lack of inflation he argued that there was no cumulative process and as your quotes suggest, Hawtrey implied that because of its non-inflationary nature due the ability of Strong at the Fed to maintain monetary stability it equated to a period of stability.

So he does describe credit relaxation in conjunction with record profits but as you state he argues that this is not a problem because of the stability of the price level.

The weakness in his argument is I think still around price stability given the level of productivity growth. ie If productivity growth were stable then price stability makes sense. Hawtrey’s data shows the demand for labour over the period was weak due to capital substitution in manufacturing. Women also entered the workforce in record numbers at lower rates of pay and given the falling prices over the period real wages were rising anyway subduing nominal wage demands. I was going to quote something from Leijonhufvud on how little we know about the way inflations works themselves through the economy to back this point up, but it’s from my notes….

Thank you David for an interesting post about Cassel and Hawtrey.
Professor Henrik Sivers at Stockholm University ,Gustav Cassels own Alma Mater. have written an paper that might interest you on Monetary Equillibrium that compare some of the students of Gustav Cassel and Knut Wicksell and the debate and thoughts on monetary economics that at the time 1910-40 in Sweden was at pretty high level,but rather unknown outside Sweden, All the best to you!

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.